Rupiah Exchange Rate Indonesia: Stronger on Fuel Subsidy Reform

However, after touching a 16-year low last week, the rupiah has appreciated markedly due to intervention by Indonesia’s central bank (Bank Indonesia) as well as news about the government’s fixed fuel subsidy policy plan (reportedly to be implemented next month). The Joko Widodo-led government aims to replace the decade-old fuel subsidy mechanism (in which the amount of subsidy spending depends on global oil prices) by a fixed subsidy amount of between IDR 1,000 and IDR 2,000 per liter for low-octane gasoline and diesel, or, scrapping gasoline subsidies altogether. Such a move would imply that public spending on fuel subsidies would be reduced to 2.5 percent of total state spending (compared to 9 percent currently, or 13.5 percent before the November 2014 subsidized fuel price hike). Moreover, Indonesia could see rating upgrades from international credit rating agencies.

In November 2014, President Joko Widodo had already raised subsidized fuel prices by more than 30 percent in a move to make more fiscal space for structural public investments (for economic and social development) as well as to limit the country’s trade deficit (and current account deficit) which is primarily caused by costly oil imports. The wide current account deficit makes Indonesia highly vulnerable in times of global economic shocks as this deficit indicates that the country depends on foreign funding. Ahead of looming higher US interest rates in the second or third quarter of 2015, Indonesia thus may be hit harder by capital outflows compared to other emerging economies unless Indonesia works hard to limit the current account deficit. Restructuring the country’s fuel subsidy scheme is a sign that the government of Indonesia is working hard to regain international confidence, leading to an appreciating rupiah. Last week, Indonesian Finance Minister Bambang Brodjonegoro said that the new fuel subsidy mechanism will be decided upon soon (perhaps even before the year-end).

This week, due to investors’ approval of fuel subsidy reforms, Indonesia’s bonds advanced with the ten-year yield falling by the most since October. The yield on sovereign notes due March 2024 fell 0.18 percent from 19 December 2014 to 7.88 percent today (9:37 am local Jakarta time), prices from the Inter Dealer Market Association show.

Bank Indonesia's benchmark rupiah rate (Jakarta Interbank Spot Dollar Rate, abbreviated JISDOR) depreciated 0.09 percent to IDR 12,467 per US dollar on Wednesday (24/12).

| Source: Bank Indonesia

It is expected that the movement of the rupiah against the US dollar will remain relatively stagnant in the last days of 2014 as global volatility has eased. However, in the first half of 2015 challenges may reappear as the US Federal Reserve is expected to announce to raise its key Fed Fund Rate amid a structurally improving US economy. Emerging markets will be affected by capital outflows as the era of ‘cheap’ US dollars (triggered by US quantitative easing) in combination with near-zero US interest rates is over and therefore funds will flow from risky (yet lucrative) emerging market assets back to the USA.

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